It is a well-known fact that the human population is addicted to coffee. In America over half of the adult population consumes coffee every day. Companies like Starbucks Corporation (NASDAQ:SBUX) have shown that people like to get their coffee from a familiar face, and they don’t mind paying a premium. The problem is that market has gotten overly comfortable with coffee retailers. Starbucks Corporation (NASDAQ:SBUX) alone trades at a price to earnings (P/E) ratio around 35.
The bullish argument around Starbucks Corporation (NASDAQ:SBUX) centers on its growth. Starbucks has become a global giant, but it keeps on expanding. It is expected to open over 1300 new stores in 2013. Yet, there is a limit to Starbucks Corporation (NASDAQ:SBUX) growth. The company is a coffee chain, and there are only so many coffee stores that can be opened. In 2008 the company was forced to close 600 stores, as it had over-expanded and a number of stores were left unprofitable. Unabated store expansions could easily place the company in a similar situation.
With yearly revenue already over $13 billion and a strong presence throughout the globe, Starbucks Corporation (NASDAQ:SBUX)’ P/E ratio should be falling. The company’s growth prospects are shrinking as it grows. Yet, the market is expanding its valuation multiple.
The company itself has a great brand name and a strong future. It is secure with a very low total debt to equity ratio of 0.1, a profit margin of 10.8% and a return on investments (ROI) of 25.8%. At a P/E ratio around 35, it is not being priced as the maturing corporation that it is. Such expanding valuations should be reserved for quickly growing tech companies, like Google in 2006.
Starbucks is not the only one
Dunkin Brands Group Inc (NASDAQ:DNKN) is famous for its Dunkin Donuts and Baskin-Robbins franchises. Starbucks Corporation (NASDAQ:SBUX) has more than 18,000 stores worldwide while Dunkin Donuts had 10,500 at the end of 2012. These numbers show that Dunkin Donuts has more room to expand than Starbucks, but it also has its limit. Dunkin Brands Group Inc (NASDAQ:DNKN)’ recent quarterly U.S. comparable same store sales (comp) growth has slowed to 1.7% from its earlier highs of 7.4%.
The biggest growth opportunity for Dunkin Donuts comes by expanding west of the Mississippi. In its core market it has one store per 9,300 people, but in the West it only has one store per 810,000 people.
Even with growth opportunities, it is hard to justify Dunkin Brands Group Inc (NASDAQ:DNKN)’ valuation. It is currently trading at a P/E ratio around 46. If the company were to double its profits by doubling its store count, its P/E ratio would still be around 23. With falling comp growth it is hard to justify such a high valuation. Dunkin Brands Group Inc (NASDAQ:DNKN) is profitable with a profit margin of 15.8% and a ROI of 4.8%, but that does not make the company a deal at such prices.